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>The financial crisis was born out of over-enthusiastic mortgage lending - i.e your basic retail product. Even lehman brothers, a classic IB, went down due to i

by b1daly 13y ago

>The financial crisis was born out of over-enthusiastic mortgage lending - i.e your basic retail product. Even lehman brothers, a classic IB, went down due to it's large commercial property portfolio which tanked in the crisis (again, nothing to do with derivatives). How can you possibly say this? It was mortgage backed securities (derivatives) and collateralized debt obligations (derivatives of derivatives) that were the main product that allowed excessive lending, by obscuring the true risks. It was the markets for these securities that froze, causing the liquidity crisis that drove the financial crisis.

retube 13y ago
An MBS is NOT a derivative. It's a cash product. Either way you're missing the point. Securitisation is just a way of funding lending. Whether you use deposits, borrow from the money markets, or securitise loans, the money to make those loans has to come from somewhere. Ultimately it was mortgage brokers and the retail banks (or retail arms of universal banks) that sanctioned these mortgages and lent money to highly unsuitable people. Yes they were securitised and sold on but as I say above this is just a funding mechanism. Yes the IBs have some responsibility for not checking the quality of the loans but then there's an argument that should have been done already by the retail side. And of course no-one imagined that default rates would ever get as high as they did - which did wipe out some MBS and CDO tranches resulting in large losses for the holders. As an indication these types of issuance were typically stressed at default rates of 10% - and that was considered extremely conservative. What actually happened was some of these mortgage pools were so crappy default rates hit 80% or 90%.
- redblacktree 13y ago
  Why would a mortgage broker care to do his due diligence, if he knows he'll sell the loan tomorrow, and take none of the risk of default? This is about incentives. Incentives that were bound to lead to excessive risk taking and an inevitable crash.
- nissimk 13y ago
  Derivative does not equal swap. MBS is definitely a derivative. It's a bond whose price and cash flow is based on an underlying pool of loans. The mortgage loans themselves are not derivatives, but mbs are. Stock options are cash products and they are most certainly derivatives.
  - retube 13y ago
    Sorry you are wrong. MBS is not classed as a derivative. As pointed out above it's actually a structured finance product. But anyway as a simple sum of underlying cash products it's still a cash product (you pay upfront cash equal to the notional of the instrument) A stock option on the other hand is most definately NOT a cash product, although the underlying is. The stock itself is not traded , it's just a financial contract whose value is a function of the stock price.
simonh 13y ago
It was the massively popular government policies of aggressively encouraging lending to people flatly incapable of replaying the loans. This was the problem. Of course they're doing it again. Promising people they can have a house that they actually can't afford is a huge vote winner. Rigging the market to make sure property prices go up, making home owners feel wealthier is a huge vote winner. Blaming nasty bankers for making it all go wrong also neatly avoids having to take any of the blame. Take the Greek and Spanish economic problems. Spain was in massive property bubble mode for the entire 2000s. The Greek government was willfully deceiving both it's people and the EU about it's finances. We're expected to believe that these issues would all have worked out fine, and these economies would have naturally stabilized all by themselves if it weren't for the wicked machinations of the US treasury? Really? Of course Lehmans and the other banks badly underestimated their exposure, but the regulators that are cracking down on the banking industry now and ticking them off for being so greedy, were themselves willfully ignoring all the signs of danger before the crash because it was politically expedient to do so. It was politically expedient because that's what the voting public wanted to believe. Nobody came out of the crash smelling of roses.
001sky 13y ago
You're confusing structured finance and derivatives. While this may seem easy to do, its based on a simplistic inference of the english modifiers. The primary things that got the housing crisis going were variations of debt contracts. The parties to these contracts were borrowers (ie, home owners) and Lenders (banks, etc). It takes both sides to agree on entering the underlying contracts (eg subprime loans). There is real cash between the parties and real "services" being rendered in the sense of capital allocation in the economy. A derivative, on the other hand, is a contract between to parties that <has nothing to do contractually> with the underlying assets, with respect to their initial deployment of capital. Example: a derivative on a stock, is not a contract between the stock issuing company and another thrid party; the derivative contract does not fund a business plan directly nor receive payment from the company per-se [1]. The controversy around derivatives and their regulation has <precisely> to do with this disconnect, actually. [1] Except incidentally.
- b1daly 13y ago
  I appreciate the technical correction in the difference between derivatives and structured debt backed securities, I did not know of this important distinction. In any case I was responding to the contention that financial crisis of 2008 was driven by "overly enthusiastic" retail bank style lending practices. By my lay persons reasoning it seems clear that the new forms of mortgage backed securities played a significant role in perpetuating the mortgage bubble, as their complicated structures enabled,at the least, shady practices on the part of the ratings agencies, loan originators, and banks. Derivatives did have some role in the crisis, as they were at the root of the highest profile firm failure, AIG (credit default swaps).

by b1daly 13y ago

retube 13y ago

An MBS is NOT a derivative. It's a cash product. Either way you're missing the point. Securitisation is just a way of funding lending. Whether you use deposits, borrow from the money markets, or securitise loans, the money to make those loans has to come from somewhere. Ultimately it was mortgage brokers and the retail banks (or retail arms of universal banks) that sanctioned these mortgages and lent money to highly unsuitable people. Yes they were securitised and sold on but as I say above this is just a funding mechanism. Yes the IBs have some responsibility for not checking the quality of the loans but then there's an argument that should have been done already by the retail side. And of course no-one imagined that default rates would ever get as high as they did - which did wipe out some MBS and CDO tranches resulting in large losses for the holders. As an indication these types of issuance were typically stressed at default rates of 10% - and that was considered extremely conservative. What actually happened was some of these mortgage pools were so crappy default rates hit 80% or 90%.

redblacktree 13y ago
Why would a mortgage broker care to do his due diligence, if he knows he'll sell the loan tomorrow, and take none of the risk of default? This is about incentives. Incentives that were bound to lead to excessive risk taking and an inevitable crash.
nissimk 13y ago
Derivative does not equal swap. MBS is definitely a derivative. It's a bond whose price and cash flow is based on an underlying pool of loans. The mortgage loans themselves are not derivatives, but mbs are. Stock options are cash products and they are most certainly derivatives.
- retube 13y ago
  Sorry you are wrong. MBS is not classed as a derivative. As pointed out above it's actually a structured finance product. But anyway as a simple sum of underlying cash products it's still a cash product (you pay upfront cash equal to the notional of the instrument) A stock option on the other hand is most definately NOT a cash product, although the underlying is. The stock itself is not traded , it's just a financial contract whose value is a function of the stock price.

simonh 13y ago

It was the massively popular government policies of aggressively encouraging lending to people flatly incapable of replaying the loans. This was the problem. Of course they're doing it again. Promising people they can have a house that they actually can't afford is a huge vote winner. Rigging the market to make sure property prices go up, making home owners feel wealthier is a huge vote winner. Blaming nasty bankers for making it all go wrong also neatly avoids having to take any of the blame. Take the Greek and Spanish economic problems. Spain was in massive property bubble mode for the entire 2000s. The Greek government was willfully deceiving both it's people and the EU about it's finances. We're expected to believe that these issues would all have worked out fine, and these economies would have naturally stabilized all by themselves if it weren't for the wicked machinations of the US treasury? Really? Of course Lehmans and the other banks badly underestimated their exposure, but the regulators that are cracking down on the banking industry now and ticking them off for being so greedy, were themselves willfully ignoring all the signs of danger before the crash because it was politically expedient to do so. It was politically expedient because that's what the voting public wanted to believe. Nobody came out of the crash smelling of roses.

001sky 13y ago

You're confusing structured finance and derivatives. While this may seem easy to do, its based on a simplistic inference of the english modifiers. The primary things that got the housing crisis going were variations of debt contracts. The parties to these contracts were borrowers (ie, home owners) and Lenders (banks, etc). It takes both sides to agree on entering the underlying contracts (eg subprime loans). There is real cash between the parties and real "services" being rendered in the sense of capital allocation in the economy. A derivative, on the other hand, is a contract between to parties that <has nothing to do contractually> with the underlying assets, with respect to their initial deployment of capital. Example: a derivative on a stock, is not a contract between the stock issuing company and another thrid party; the derivative contract does not fund a business plan directly nor receive payment from the company per-se [1]. The controversy around derivatives and their regulation has <precisely> to do with this disconnect, actually. [1] Except incidentally.

b1daly 13y ago
I appreciate the technical correction in the difference between derivatives and structured debt backed securities, I did not know of this important distinction. In any case I was responding to the contention that financial crisis of 2008 was driven by "overly enthusiastic" retail bank style lending practices. By my lay persons reasoning it seems clear that the new forms of mortgage backed securities played a significant role in perpetuating the mortgage bubble, as their complicated structures enabled,at the least, shady practices on the part of the ratings agencies, loan originators, and banks. Derivatives did have some role in the crisis, as they were at the root of the highest profile firm failure, AIG (credit default swaps).